U.S. Buyout Firms Ring Into Canadian Market –

U.S. private equity professionals are making a run for the border, but they’re not all headed south. In the last year, buyout firms have participated in several noteworthy acquisitions of Canadian companies, sending more than $2 billion to the Great White North, and sources say this is just the tip of the iceberg, especially in the telecommunications sector.

The limited number of Canadian private equity firms can’t compete for large deals due to the limited sizes of their funds, sending capital-hungry companies to deep-pocketed U.S. investors. In particular, deregulation of the Canadian telecommunications industry is allowing U.S. firms like The Carlyle Group and Charlesbank Capital Partners to add Canadian competitive local exchange carriers (CLECs) to their portfolios in anticipation of the consolidation expected in that industry. While other U.S. firms, including Kohlberg Kravis Roberts & Co., have ventured into Canada for investments in a variety of industries, market observers are pointing to telecom for most of the action.

Telecom Offers Sample Taste

Sources say the telecommunications situation in Canada somewhat resembles the breakup of the telephone monopoly in the U.S. almost 20 years ago, when the government dissolved AT&T Corp.’s hold on long-distance telephony. Sources say the dynamic nature of telecommunications in Canada can be attributed to the gradual crumbling of an industry alliance called the Stentor Group, which has been disbanding over the last five years.

The Stentor Group, which originally was made up of Canada’s 11 major telephone companies-Bell Canada, BC Tel, Island Tel, MTS, MT&T, Telus, Manitoba Telecom Services, NBTel, NewTel Communications, QuebecTel and SaskTel-had vowed to act as one company in order to eliminate competition among themselves and, as a result, created a huge monopoly.

In short, competition for local phone service was not permitted in Canada before mid-1997 because of this pact, which hadn’t even been challenged until lobbying against it began in 1996. The lobbying effort led to changes enforced by the Canadian Radio-Television Telecommunications Commission that opened up the local phone markets and aided in Stentor Group’s eventual dissolution. That legislation, coupled with the decision of the group’s members that a competitive environment would be healthier than the monopolistic history, brought the Stentor Group to an end.

Since the breakup of the alliance, CLECs have been springing up all over Canada, promoting competition among themselves as well as with the big-name players who were once part of the Stentor Group, and they are looking for funding wherever they can get it.

Wynnchurch’s Hatherly also cites the emergence of a Canadian middle market where younger companies have built themselves up and now need additional capital to keep moving forward.

While other U.S. firms are just getting started in the industry, one picked up on the potentially profitable investment in Canadian CLECs before anyone else and recently exited its investment. Providence Equity Partners, which invests in media and telecommunications, saw a 15-times return in May on its two-year investment in the first-ever Canadian CLEC, MetroNet Communications Corp., when the company merged with AT&T Canada Corp. Providence lobbied the Canadian parliament in 1996 and 1997 for deregulation of the local phone markets and assisted in drafting legislation, opening the door for CLECs to move into the established telephone companies’ traditional turf.

More recently, The Carlyle Group injected C$200 million ($134 million) in the form of convertible preferred shares into Videotron Telecom, a subsidiary of communications conglomerate Le Groupe Videotron Ltee, to fund the national expansion of its regional phone operations to business customers.

Frank Yeary, managing director for Carlyle, said his firm has been eyeing Canada’s local telecommunications market since deregulation began. He said compared with the U.S., Canada’s local telecom industry has fewer competitors, which will allow the company to expand more rapidly and make acquisitions of other CLECs along the way.

Videotron Telecom Chairman Claude Chagnon said his company plans to be the next MetroNet and has the equity and infrastructure already in place to give it a head start over other hopeful CLECs.

Meanwhile, another U.S. private equity firm in the Canadian CLEC fray is pitting two American buyout groups against each other in the race to claim Canadian cities as their own. Charlesbank Capital this month announced that it will invest up to C$30.5 million ($20 million) to finance the expansion of C1 Communications. The Toronto-based company aims to become a leading provider of telecommunications services across Canada, a goal shared by other CLECs. Charlesbank Capital Managing Director Tim Palmer said he is confident in C1’s ability to expand to new markets faster than others and meet the increased demand for greater speed, functionality and range of communication services. C1 plans to sell wholesale digital subscriber line (DSL) services to Internet service providers and enterprise customers starting this fall in eastern Canada, moving into Toronto next year.

Beyond Telcos, Drug Stores?

The most high-profile deal done recently in Canada has nothing to do with telecommunications or the Internet, but it nonetheless made an impression on market observers because of its size and the players involved.

Earlier this month, KKR agreed to lead the purchase of Canadian drug store Shoppers Drug Mart/Pharmaprix for approximately C$2.55 billion ($1.7 billion) from Imasco Ltd. in one of the largest private equity deals done in Canada. Upon the transaction’s close, the group of investors, which includes Bain Capital, Charlesbank Capital, DLJ Merchant Banking, the Ontario Teachers’ Pension Plan Board and the company’s management, will contribute $900 million in equity toward the transaction.

Mathew Lori, a managing partner at Chase Capital Partners, says no Canadian private equity firm can do a deal of this size, although Canadian strategic investors did make bids on the drugstore chain. The deal was there for the taking, Lori says, as Imasco’s parent, British American Tobacco plc, acquired the half of Imasco it did not already own and required that the company rid itself of non-tobacco-related assets.

After the KKR bid won out, two Canadian drugstore owners who submitted bids for Shoppers Drug Mart reportedly said the KKR-led group would be paying too much for the company. However, Lori says, both sides got what they wanted: KKR notched a good investment and the company got funding and expertise from the most well-known buyout group in the world.

Another G.P. source whose firm does Canadian and U.S. deals said no conclusions can be drawn from the Shoppers Drug Mart deal. It skews the numbers for deals waiting to be done in Canada because it was a one-time occurrence with very few like it, he says. “Companies will always be divesting of their non-core assets, and you just can’t call it a trend every time Americans see a good deal somewhere else,” he says. “There won’t be another Shoppers Drug Mart deal in Canada for a while.”

In addition to the Canadian deals U.S. groups have notched in their belts, at least two groups are in partnerships with Canadian counterparts to invest in Canadian companies, instead of going it alone.

Chase Capital in September partnered with Toronto-based Harrowston Inc., a publicly traded private equity group. Each has committed $100 million to the joint venture, which will pursue all levels of investments but has yet to close any deals.

Chase’s Lori said this set-up resembles other regional ventures that Chase Capital has started in India, Italy, Spain and Ireland, in which the firm has teamed with a partner that has established local contacts.

He also said the Canada partnership appealed to Chase because Canada’s private equity market is in its early stages, thus Canadian companies in need of capital still look south of the border for money.

Let the Fund Launches Begin

Two former GE Capital Corp. merchant banking executives this summer launched a $250 million buyout fund with the support of Bain Capital to pursue investments in the Midwest and Canada. The two executives, John Hatherly and Jon Tomes, teamed with Canadian investor Richard Renault to form Wynnchurch Capital Partners, L.P. Hatherly said the Canadian focus can be credited to the relationship with Renault, who has a long history of investing in underperforming Canadian companies. Hatherly also cites the emergence of a Canadian middle market where younger companies have built themselves up and now need additional capital to keep moving forward.

Wynnchurch’s fund will hold a first close soon, Hatherly says, declining to comment on any deals in the making.

Throughout 1999, Canada has been a deal destination for numerous other U.S. buyout shops.

In December 1998, CM Equity Partners bought Regal Confections Inc., a candy distribution business, for approximately C$17.6 million ($11.6 million) to be added to CM Equity’s Beta Brands platform. BG Affiliates notched its first Canadian buyout back in 1997 and has come back to the market this year, rolling up Canadian janitorial service companies. Also, Berkshire Partners this summer purchased a majority stake in TELAV Inc. a Canadian audio-visual equipment rental company.